Inflation, The Stress Test, and The Difference Between; Fixed, Variable and Adjustable Rates. 

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mortgage inflation stress test update 2022

Mortgage Market Update: June 2022

Inflation

May’s inflation reports suggest that the CPI reading is expected to range between 7.1% and 7.5%. That would make it the highest inflation print since 1983 when the prime rate was 11.5%. Markets are usually good at setting 5-year fixed rates at a level that reflects expectations about future variable-rate fluctuations. In other words, the bond market is telling us that the overnight rate will rise to around 3%. 



How is Inflation Affecting Recent Changes in Mortgage Rates?

As most of our readers know, the mortgage world has undergone quite a few changes in the last few years. From record-breaking lows to new record-breaking highs, many have found themselves having a hard time keeping up. To name a few topics on the tips on everyone’s tongue are inflation and increases in the prime lending rate. Many are aware of the differences between the fixed, variable & adjustable rate mortgages, but not everyone is aware of the implications when choosing which mortgage type to take. 


Determining Fixed Rates.

Canadian 5-year fixed rates move with 5-year bond yields. Canadian yields are determined by a variety of factors, but essentially they reflect the expected overnight rate of the Bank of Canada over the next half-decade, plus a term premium. Term premiums refer to investor demand for an extra yield for locking up their money for five years. 




Variable or Adjustable – What Is The Difference?

Due to increasing inflationary pressures in the economy, the Bank of Canada has been forced to act swiftly with successive increases to the overnight lending rate in 2022 in an attempt to cool off our overheated economy. These increases in the overnight rate are causing some sleepless nights for many of those who chose to take a variable or adjustable rate for their mortgage. As a result of the increases to the prime rate, those borrowers will now be paying more interest each month. 

Although both mortgage types are susceptible to fluctuations in the prime rate, there are differences. The primary difference between a variable rate and an adjustable-rate is that variable-rate mortgage payments do not fluctuate with movements in the prime rate, whereas adjustable-rate mortgage payments will increase or decrease with movements in the prime lending rate. Since the variable rate payment does not move with rate fluctuations in the prime rate, the amount going towards principal versus interest is what changes. 

Read our blog about the implications of locking into a fixed mortgage rate from a variable rate. Before making any rate-change decisions, be sure to contact your mortgage professional for a consultation. Call us today at 604-889-7343.





Today’s Rates and Their Effects on Your Borrowing Power

Many Canadian Mortgage holders are aware of the Stress Test. Simply put, the mortgage stress test determines if you’ll still be able to pay your mortgage should interest rates rise. It provides guidance on qualifying rules. Mortgage providers use it to calculate whether you qualify for a mortgage and how much you can borrow. It tests you at a theoretically higher rate to see if you could still afford your payments at that higher rate. Based on its results, it decides the actual mortgage amount you may be approved for. 


The Stress Test

As stated in the previous paragraph, the Stress Test, “tests” the mortgage application at a theoretically higher rate. Why? To see if the borrower(s) could still afford the monthly payments at that higher rate. Based on its results, it decides the actual mortgage amount you may be approved for. 

The rule of thumb with the Stress Test is that it is calculated at either the Prime Rate (Currently 5.25%) or 2% above your actual rate, whichever is higher. For example: In today’s current interest rate environment, the 5-year fixed mortgage rates currently exceed 5%, and the government of Canada has decided that you must test the greater between the Prime Rate (5.25%) and your actual rate + 2%. Therefore, if you have a fixed mortgage rate of 5.3%, you will be stress-tested at 7.3% instead of 5.25%, since the rate is higher. As a result of this policy, borrowers are forced to qualify for a much higher mortgage payment than what they are contractually obligated to pay the lender, which reduces their approval capacity. 

Many borrowers have been choosing variable-rate mortgages as of late. The reason? To maximize their mortgage approval amount, even if their personal preference is for a fixed-rate mortgage. The current discrepancy between fixed and variable rate mortgages is enough to justify most borrowers’ decisions. Floating-rate mortgages continue to out-favour 5-year fixed terms. Variable rates are priced an average of 1.84% lower than a 5-year fixed-rate— Making it highly convincing in today’s market.


Inflation, stress test and other mortgage market updates




The Takeaway

The main takeaway is that with today’s rates, the average borrower qualifies for a larger mortgage amount with a variable rate, or with a shorter fixed-rate term. Depending on your debt-servicing ratios, or the amount used to determine your monthly expenditures, paired with the mortgage product you receive will largely determine your borrowing capabilities. 

The next Bank of Canada rate announcement will be on July 13th, 2022. At which time the market estimates that the Prime rate will once again increase by .75%. Subsequently, all variable rate mortgages will also rise. However, what comes up, must also eventually come back down— or at least flatten out. 

Clearly, this can be a lot for inexperienced borrowers to figure out. Especially if they are first-time homebuyers or new to Canada. Finding the best mortgage solution for you is a much larger picture than just finding the best rate. It really comes down to who you are and what your current situation is. 

For those looking for some expert advice in an increasingly difficult rate environment, we suggest that you reach out to a mortgage professional. We can assist you in determining the most appropriate

solution to your specific needs. 

mortgage professional vancouver

If you would like to schedule a consultation, or simply want to give us a call, we are happy to help in any way we can. Even if it’s to provide a little peace of mind during these complicated times. 

Contact Darcy Doyle at the Mortgage Professionals today by calling 604-889-7343 or send us an email at darcy@themortgageprofessionals.ca

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